Changes to UK pensions: how will they affect you?
By Spectrum IFA
This article is published on: 14th April 2015
This year brings about major changes in UK pension rules. Under the reform named ‘Freedom and Choice in Pensions’, which comes into effect in April 2015, people will be provided with greater choice about how and when they can take their benefits from certain types of pension arrangements.
Following proposals first made in March last year, subsequent consultation resulted in the Pensions Taxation Bill being published in August, with further amendments then being made in the October.
Additionally, some provisions were clarified in the autumn budget statement. Therefore, subject to there not being any further changes before the imminent enactment of the legislation, we can be reasonably certain of the new rules.
TYPES OF PENSION
To understand the reform, you need to understand the two main types of pensions:
- The first is the Defined Benefit Pension (DB), where your employer basically promises to pay you a certain amount of pension, which is calculated by reference to your service and your earnings. DBs are a rare breed now, as employers have found this type of arrangement too costly to maintain.
This is because the liability for financing the scheme falls upon the employer (after anything that the individual is required to contribute) and if there is any shortfall in assets to meet the liabilities – perhaps because of poor investment returns – the employer must put more money into the scheme.
- The second type of pension is the Money Purchase Plan (MPP). You put money into an MPP, as does your employer, the government (in the form of tax rebates) and, in the past, national insurance contribution rebates.
For some, your MPP was not arranged through an employer at all and you just set up something directly yourself with an insurance company.
There are several different types of MPP arrangements, but they all result in the same basic outcome. The amount of the pension that you receive depends on the value of your pension pot at retirement and so the investment risk rests with you. There is no promise from anyone and no certainty of what you might receive.
The proposed reform is all about MPPs, although there is nothing to stop a person from transferring their private DB to an MPP if they have left the service of the former employer.
The majority of the changes will be effective from 6 April 2015 and these will apply to money purchase pension arrangements only. Therefore, people with deferred pension benefits in funded defined benefit plans, who wish to avail themselves of the changes, must first of all transfer their benefits to a money purchase scheme. Members of unfunded public sector pension schemes will not be allowed to make such a transfer.
Under the new rules, people will be able to take all the money in their pension pot as a one-off lump sum or as several lump sum payments. For UK-resident taxpayers, 25% of each amount will be paid tax free and the balance will be subject to income tax at the marginal rate (the highest being 45%).
Alternatively, it will be possible to take 25% of the total fund as a cash payment (again, tax free for UK residents) and then draw an income from the remaining fund (taxed at the marginal rate). The commencement of income withdrawal can be deferred for as long as the person wishes. Furthermore, there will be no minimum or maximum amount imposed on the amount that can be withdrawn in any year.
The annual allowance, which is the amount of tax-relieved pension contributions that can be paid into a pension fund, is currently £40,000 per annum. For anyone who flexibly accesses their pension funds in one of the above ways, the annual allowance will be reduced to £10,000 for further amounts contributed to a money purchase arrangement.
However, the full annual allowance of up to £40,000 (depending upon the value of new money purchase pension savings) will be retained for further DB savings.
The ‘small pots’ rules will still apply for pension pots valued at less than £10,000. People will be allowed to take up to three small pots from non-occupational schemes and there is no limit on the number of small pot lump sums that may be paid from occupational schemes. For a UK resident, 25% of the pot will be tax free. Accessing small pension pots will not affect the annual allowance applicable to other pension savings.
The required minimum pension age from which people can start to draw upon their pension funds will be set at 55, except in cases of ill health, when it may be possible to access the funds earlier. However, this will progressively change to age 57 from 2028; subsequently, it will be set as 10 years below the state pension age.
The widely reported removal of the 55% death tax on UK pension funds has been clarified. Thus, whether or not any retirement benefits have already been paid from the money purchase fund (including any tax-free lump sum), the following will apply from 6 April 2015:
- In the event of a pension member’s death below the age of 75, the remaining pension fund will pass to any nominated beneficiary and the beneficiary will not have any UK tax liability. This is whether the fund is taken as a single lump sum or accessed as income drawdown.
- If the pension member is over the age of 75 at death, the beneficiary will be taxed at their marginal rate of income tax on any income drawn from the fund, or at the rate of 45% if the whole of the fund is taken as a lump sum. From April 2016, lump sum payments will be taxed at a beneficiary’s marginal tax rate.
There will be more flexibility for annuities purchased after 6 April 2015. For example, it will be possible to have an annuity that decreases, which could be beneficial to bridge an income gap, perhaps before state pension benefits begin. In addition, there will no longer be a limit on the guarantee period, which is currently set at a maximum of 10 years.
French residents can take advantage of the new flexibility and providing that you are registered in the French income tax system, it is possible to claim exemption from UK tax under the terms of the double-tax treaty between the UK and France.
However, there are a number of French tax implications to be considered here, and these are as follows:
- You will be liable to French income tax on the payments received, although in certain strict conditions, it may be possible for any lump sum benefits to be taxed at a fixed prélèvement rate.
- If France is responsible for the cost of your French health cover, you will then also be liable for social charges of 7.1% on the amounts received.
- The former pension assets will become part of your estate for French inheritance purposes, as well as becoming potentially liable for wealth tax.
Therefore, if you are French-resident, it is essential to seek independent financial advice from a professional who is well versed in both the UK pension rules and the French tax rules before taking any action.
Such financial advice should also include examining whether or not a transfer of your pension benefits to a Qualifying Recognised Overseas Pension Scheme (QROPS) could be in your best interest.